How to create a cash flow forecast (and why your business needs one)

A cash flow forecast is an estimation of the money you expect your business to bring in and pay out over a period of time. Quality accounting software can help you to create a cash flow forecast with relative ease, but it’s well worth understanding what a cash flow forecast actually encompasses.

It should reflect all of your likely revenue sources (like sales or other payments from customers) and compare these against your likely business expenses (like supplier payments, premises rental and tax payments).

Despite the fact that your actual annual incomings and outgoings will likely deviate from the plan throughout the year (that’s where the ‘forecast’ part comes into play) – your plan is still important. It will never stay completely accurate but it gives you an important general overview of what to expect.

Guest Tips: Accounting Expert, Benedict Gatherer

Throughout this guide, we have top tips from accounting expert Benedict Gatherer. Benedict is a Chartered Accountant who has helped countless small businesses through his accounting practice The Copper Coins. He's also written a book on accounting, and produces useful accounting videos at his YouTube channel Accounting Tea Break.

Why is a cash flow forecast important?

A cash forecast:

• Can give you a good estimate of when your business will start making a profit – By conducting 12 monthly cash forecasts, you can create an annual cash forecast to work out approximately when your company will become profitable.
• Helps you plan for business activities and growth – Even if you start with estimated or ‘dream’ sales numbers in your forecast, it will help you feel more focused and give you a mental boost to try and plan how to get there. For example, what kind of social media marketing will you use? What kind of project management systems will you use to keep track of all your ideas?
• Helps you plan for seasonality – let’s say you have a huge increase in sales expected in October. Now you can plan to spend a little more on marketing in that month, for example. Similarly, if you know you’re due a loss in a specific month, it can help you to know when to go into survival mode and buffer for that.
• Ensures your business activities are correctly aligned with your values – are you spending enough on employee engagement to increase productivity amongst your team?
• Supports you in making realistic decisions for your business – when you know where your money is going each month (all your labour costs, for example), you also know how much you have left to spend on other expenses you might want to purchase
• Gives you a sense of control over your business finances – and provides you with insight on what you could potentially cut out from your budget or what you could spend more on for increased sales, retention, etc.
• See the financial health of your business – Once you know where you’re at with your overall business performance, you can better avoid any potential issues that may lead to the failure of the business.

When should I create a cash flow forecast?

Your cash forecast plan should be created as part of your business plan, right at the beginning when you start your business. It’s okay if you haven’t yet, but as our expert Benedict states:

“Don’t put off your cash flow forecast. You might have a business model that makes a profit in the very first year, and you might meet every target you set. But if the income is at the end of the year and the spending is at the start, you might run out of cash in the middle, and watch the business fail just because you didn’t realise the cash would run out.”

Who is my cash flow forecast for?

You might be creating a cash flow forecast for yourself, your bank or potential investors and shareholders who may really want to drill down into the nitty-gritty of your business.

Here, Benedict points out:

“Who your cash flow forecast is for should affect your approach:

If it’s for yourself, then be PESSIMISTIC in all your estimates. It’s always a good idea to have a bit of a buffer in case things go wrong (and something almost always goes wrong).

If it’s for a bank or other outsider, then be OPTIMISTIC in all your estimates. You want to present your business in a flattering light, after all.

However, it’s really important to not go crazy either way – your estimates have to be realistic, or the whole forecast will be a waste of time.”

Creating a cash flow forecast: getting started

Cash forecasts typically contain:

1. Incoming costs such as sales revenue, customer account fees, or funding.

2. Outgoing costs such as staff wages, operating expenses, and any other associated labour costs. This can cover everything from advertising costs to office supplies.

What software should you use for a cash flow forecast?

While you don’t need any special software to get started with your cash flow forecast, but if you want to make things a little easier for yourself, accounting software such as Freshbooks or QuickBooks often have cashflow forecast templates you can use.

Quickbooks offers a 24 month cash flow forecast at no extra charge and you can track projects, jobs or locations to see where you’re making the most money, and Freshbooks allows you to pull data right from their software.

Check out our list of Startups.co.uk approved accounting software below:

Step 1: Create a spreadsheet

This part is simple, and can be done using Microsoft Excel, Google Sheets or OpenOffice:

First, you’ll need to decide on the length of time you want your cash flow forecast to cover. This can be week to week, month to month, or yearly (but we recommend perhaps only 1-2 years to keep things accurate because you never know how much will change – and it will! – over such a long period of time.)

Next, you will set yourself up with a simple spreadsheet with a column for the time period you’ve decided, and a row for profits and expenses which will set you up for success throughout the next 12 months, or however long you choose.

You’ll then want to add a final row at the bottom across all of them for your monthly totals (preferably in a different, eye-catching colour) where you’ll record your profit minus expenses. (More on this below)

Step 2: List all of your income

Your sources of income may include:

• (Emergency) savings
• Expected sales
• Any startup grants or loans
• Any investments you’ve received
• Dividends and interest
• etc…

When you add all of these sources together, you will have the figures of your total income.

Step 3: List all of your expenses

Your expenses may include:

• Wages and other associated labour costs
• Equipment
• Training
• Debts
• Rent on your office space or commercial building
• Electricity bills among others
• VAT liability (if applicable)
• etc…

Step 4: Work out your net income

Gross profit minus expenses = net income

For each week or month column, take away your estimated expenses from your estimated income.

That will give you either a positive cash flow figure (when you have more cash coming in than you’re spending) or a negative cash flow figure (you’re spending more than you have coming in).

You can then keep your running total to get a picture of your cash flow forecast over time. With all these figures in one place, you can easily work out the total amount your business makes per month, and the total amount your business spends each month.

Another huge added bonus of calculating all of this is that these figures will all help to make things so much clearer when tax season rolls around. You’ll already be familiar with most of the terms you need to know for your returns, and the figures to go with them.

When should you update your cash flow forecast?

Once you’ve put together your cash flow forecast, the obvious temptation is to file it away and get on with running your business.

However, to improve your cash flow forecast, the best practice is to try and update it whenever there is a significant change in either your profit or loss.

Benedict has a few key ideas for different kinds of forecasts here:

“If you’re feeling strong when you finish your forecast, make two new copies of it, then change the numbers in one to be the best possible future and one to be the worst possible future.

Shade the good one green and the bad one red. Seriously, take it from an accountant: looking at lots of similar spreadsheets will blur your vision, and bore you into making silly mistakes. Treat yourself like an idiot who needs everything clean, simple, and colourful.

Doing this will give you a much better idea of how your business would be able to cope with problems such as losing a key customer, or a sudden increase in the cost of your supplies.”

Conclusion

Getting your head around creating a cash flow forecast makes it easier to run your business, as you’ll have a reasonably accurate idea of how your cash flow looks in the months ahead.

If you really don’t have the time to tackle it however, then you can think about investing in some quality accounting software – this is optional of course, and we hope this guide has given you the knowledge and tools to be able to try creating one for yourself – but many accounting software packages have forecasting tools that save you from having to do all that number-crunching, and the good news is that most these days are HMRC-recognised and compliant with the new MTD legislation that came into effect in the UK on April 1 2022.

However you decide to create, manage, implement and optimise your cash flow forecast, may it always be sunny and profitable!